Wednesday, December 07, 2011

The Morning Call I think I can, I think I can

The Market
Technical

The indices (DJIA 12150, S&P 1258) had a relatively quiet but nonetheless up day, finishing within their respective intermediate term trading ranges (10725-12919, 1101-1372). They also closed above the down trend off the October highs (intersect at 12024, 1236)--the DJIA for the second day, the S&P for the third. Another day and our time and distance discipline will confirm the break. As positive as that is, the S&P is still struggling with its 200 day moving average (circa 1264)--it actually touched it intraday and then backed off. This moving average has been acting as a barrier for some time, so clearly busting through it is a key to moving higher.

Volume was flat; breadth mixed. The VIX was up slightly but has now traded below the upper zone of its current trading range for the fifth day--a positive for stocks.

Bottom line: to keep the upward momentum going, the S&P needs to take out its 200 day moving average. If that is done, the October highs (12293, 1292) are visible resistance and following that the upper boundaries of the current intermediate term trading ranges (12919, 1372). As you know, I think this is at good as it can get. Support exists at 11741, 1230.

Fundamental

Headlines

The only economic news yesterday was the weekly retail sales figures which were distorted by seasonal (Black Friday) factors. So nothing Market impactful there.

Europe is in serial meetings this week with all the players conferring in multiple combinations all day everyday Various rumors on options for resolving its debt problem are being floated. The big one yesterday was that two funds could be used to buy sovereign debt to help buy countries time to implement sufficient austerity plans that would permit those countries to start reducing debt; and it helped give equity prices an intraday lift.http://www.zerohedge.com/news/no-private-losses-and-efsf-x2

P.S. overnight the Germans ruled out any such dual funding and made clear not much would happen by Friday. Judging by the futures, no one believes it.

The rest of the week will likely be a carbon copy as more meetings take place and more possible solutions are rumored. The good news is that the eurocrats are making the effort to solve their problems.

However, doesn’t mean that they will succeed--which I define as reducing debt and promoting growth. Indeed, based on the rhetoric, I am not even sure they understand what has to be done to truly correct their solvency difficulties. That probably means that they will come up with some muddle through steps that prevent multiple country/bank defaults over the short term but doesn’t address the reduce debt/promote growth conundrum. Of course, muddle through is the basic assumption in our forecast, so short term I would not be concerned by such an outcome.

That said, it would probably mean that the EU/the globe will have to deal with the underlying problems one, two or three years from now. Certainly as Dougie Kass suggests below, the EU political class could come up with a ‘shock and awe’ plan; and if they do, God bless them. But to be clear, ‘shock and awe’ has to include restructuring (i.e. default, haircuts, etc) of a big chunk of PIIGS debt and a cutback in social programs accompanied by pro-growth tax measures (sort of like Greece but with bigger haircuts, all creditors taking the hit and some pro growth features). In my opinion, this is the long term ‘good news’ strategy. There would be economic pain in short term; but the Markets would probably love it. If you think that sounds like somebody is smoking dope, then you understand why my most likely case is a muddle through scenario.

Bottom line: the euros seem to be working their way to some form of a kick the can down the road strategy. While that will avoid some near term pain, it will reinforce my long term secular forecast, i.e. that of slow sluggish secular economic growth. The PIIGS simply have too much debt to service and pay off to leave room for any kind of growth other than below average. In other words, it’s Japan 2.0 for the next decade. Our Valuation Model reflects this outcome and, its calculations suggest that stocks are modestly undervalued at current levels.

There is some chance of a disaster outcome--the eurocrats can’t even get sufficient ‘muddle through’ measures enacted to placate the credit markets, sovereign debt yields skyrocket and the financial system implodes/EU breaks apart. If that occurs, our Portfolios are clearly over invested and will need to build cash quickly.http://cafehayek.com/2011/12/whats-worse-than-an-apocalypse.html

Steve Cook received his education in investments from Harvard, where he earned an MBA, New York University, where he did post graduate work in economics and financial analysis and the CFA Institute, where he earned the Chartered Financial Analysts designation in 1973. His 40 years of investment experience includes institutional portfolio management at Scudder, Stevens and Clark and Bear Stearns. Steve's goal at Strategic Stock Investments is to help other investors build wealth and benefit from the investing lessons he learned the hard way.